What is Investing?
When you hear the word investing, what comes to mind? Money? Wall Street? 2008?
Carl Richards, a US based Financial Planner, author and columnist for the New York Times breaks it down into the four things we can invest: money, time, energy and skill.
In this post, I’m going to be focusing on investing money.
An extremely simple definition of investing money is:
To put money into something with the expectation of getting more back in the future.
Well what is that something? To break it down for you, I’ve listed some of the more common or popular investing vehicles:
Savings Account: A savings account is the most basic form of investing. Your money is held at a financial institution and they pay you a small interest rate to hold it there. These institutions then make money by lending your idle cash out in the forms of mortgages, loans, etc. at higher rates.
GIC/Term Deposit: A Guaranteed Investment Certificate (GIC) or Term Deposit is very similar to a savings account, except for the fact that your money is locked-in for a certain period of time (6 months, 1 year, etc.). The Financial Institution will usually offer you a slightly higher interest rate, knowing that the funds will be locked in.
Bonds: Bonds are a type of formalized loan and are offered by governments and companies. When you purchase a bond, you lend the organization a specific amount of money for a specific amount of time.
The organization agrees to pay you interest over this time, and then reimburses you the initial amount you lent.
Stocks: When you buy a stock, you are actually purchasing a very small share of ownership in the company. Before an organization can issue stocks to everyone, they must become “public”. Stock prices go up and down every day based on people constantly buying and selling.
The most common driver of a stock price is the expectation for future profits, although with millions of irrational market participants, this isn’t always the case.
Mutual Funds: Mutual Funds are a basket of different investments (stocks, bonds, term deposits, etc.) that are offered by a Financial Institution and provide everyday investors access to professional portfolio management. These are a great way to get started, unfortunately they typically come with a high cost (which is how the financial institution gets paid).
There is a lot of debate on whether the portfolio managers can outperform the market after their expenses, but we’ll get into that another week.
Exchange Traded Funds (ETFs): Exchange Traded Funds are similar to mutual funds in that they provide a basket of different investments all with one holding. ETFs are traded in the market similar to stocks, differing from Mutual Funds which are offered directly by the Financial Institutions.
ETFs have garnered a lot of popularity recently as they tend to be a fraction of the cost of a Mutual Fund while still providing global diversification. We will get into the pros and cons in an upcoming post.
There are also alternative investments outside the standard ones listed above. These investment vehicles are considered more exciting – as they attempt to provide superior returns and are often reserved for high-net-worth portfolios.
Real Estate – This is a very well known investment type. Whether you are buying real estate to rent out, flip or live in, Real Estate is one of the most common vehicles investors use that want something different than a stock portfolio. There are also Real Estate Investment Trusts (REITs), which act similar to a Mutual Fund or ETF and allow you access to professional real estate management for an ongoing fee.
Private Equity – This is investing in companies that have not gone public yet, and cannot offer shares to the general market. Silicon Valley is the most popular place for private equity, with billions of dollars being invested in start-ups with the hopes that they are the next Facebook or Snapchat.
There are other investment strategies and techniques out there used by advanced investors but they are beyond the scope of this article (and honestly, complexity in investing does not equal better returns).
Why do we invest our money anyways?
In my mind, there are two main reasons we invest money:
- To maintain our purchasing power
- To achieve Financial Independence (or other financial goals)
The first reason is simple. Have you ever heard your parents talk about how they used to go to the movies for $1… and that included popcorn and a drink?
The reason we now pay $15+ to go see a movie is inflation. Over time, the general price of goods and services increases. To ensure that we can keep up with rising prices over our life-time, we must invest our money to outpace inflation.
Some people get nervous when investing as there is a chance that the value can go down. While this is true, there is also guaranteed risk in not-investing, as we lose our purchasing power over time to inflation.
The second reason is to achieve Financial Independence (or another financial goal). The main source of our savings is our income we earn over our lifetime. But rather than let those hard-earned dollars sit in a savings account earning nothing, it is much wiser to invest these funds and have your money work for you.
When investing our savings, we not only outpace inflation, but we can expedite the time to reaching Financial Independence (the moment when we work because we want to, not because we have to).
By building a properly structured portfolio, we can create a future passive income stream for ourselves that can one day replace our income.
Stay tuned as I will be building out this guide week by week. Next, we will get into the details of smart investing and how to start structuring your own portfolio.